Minutes of the Monetary Policy Meeting of the Reserve Bank Board

Hybrid – 6 December 2022

Members participating

Philip Lowe (Governor and Chair), Michele Bullock (Deputy Governor), Mark Barnaba AM, Wendy Craik AM, Ian Harper AO, Carolyn Hewson AO, Steven Kennedy PSM, Carol Schwartz AO

Members had granted leave of absence to Alison Watkins AM, in accordance with section 18A of the Reserve Bank Act 1959.

Others participating

Luci Ellis (Assistant Governor, Economic), Christopher Kent (Assistant Governor, Financial Markets)

Anthony Dickman (Secretary), David Jacobs (Deputy Secretary)

Jonathan Kearns (Head, Domestic Markets Department), Marion Kohler (Head, Economic Analysis Department), Penelope Smith (Head, International Department)

International economic developments

Members commenced their discussion by observing that global inflation remained high. However, inflation appeared to have peaked in a number of countries as oil prices declined, supply-chain pressures eased and economic growth slowed. Activity in most advanced economies was growing only modestly, and had begun to contract in the United Kingdom. The Chinese economy also continued to face challenges, particularly due to ongoing COVID-19 containment measures there.

The monthly inflation data for October showed an easing in the pace of core inflation in the United States and Canada. Headline inflation had also eased as energy prices had fallen, although food price inflation remained strong. Forward indicators pointed to a further moderation in goods price inflation as supply chains continued to normalise. The data suggested that inventories were returning to more typical levels, supplier delivery times were becoming shorter and shipping costs were continuing to fall.

By contrast, inflation in the services sector remained high, underpinned by strong demand and rapid wages growth, and, while services inflation appeared to have levelled out recently, it was unlikely to abate quickly. Members also noted that the situation in Europe was less encouraging, with little sign of inflation easing amid very strong energy price rises.

Most advanced economies grew modestly in the September quarter, supported by the ongoing recovery in services consumption and business investment. The clearest signs of the effect of rising interest rates were in the housing sector; residential investment had contracted and housing prices had been steady or were declining across a range of economies. That said, surveyed business conditions had also softened over preceding months and investment intentions had fallen below longer run average levels. Slower growth in advanced economies had seen labour demand ease modestly and wages growth start to level out at a high rate, although labour markets remained very tight in most countries. Demand for exports from east Asian economies had also fallen in preceding months.

Members discussed the significant challenges facing the Chinese economy from the management of COVID-19. A number of large cities – including Beijing, Guangzhou and Chongqing – had imposed containment measures, which had slowed mobility and economic activity. While Chinese authorities had announced some adjustments to their COVID-19 containment strategy, the measures being implemented remained stringent by international standards.

Demand for housing in China remained weak, which was affecting residential construction and the financial viability of numerous developers. Private fixed-asset investment had been little changed in preceding months, with the weakness in property investment offsetting growth in the other components of investment. Members noted that the Chinese authorities had recently announced a package of measures to support financing of the property sector. While the package was unlikely to lift demand for property significantly, it had nevertheless helped boost market sentiment regarding the property sector in China; this, in turn, had supported a rise in iron ore prices over the prior month, although prices remained well below the levels seen earlier in the year.

Base metals prices had also risen over November. Energy prices had generally declined owing to a mild European winter and in response to the weak outlook for global growth. The main exception had been the price of gas in Europe, where a decline in October had been reversed in November with the onset of colder weather. Gas prices, however, were still well below their August peaks.

Domestic economic developments

Turning to the domestic economy, members observed that the recent data were largely in line with the assessment of the economy at the November meeting. Labour demand remained strong but employment growth had slowed in recent months. The tightness in the labour market and high inflation had led to a further increase in wages growth. This was particularly the case in the private sector, where the latest indicators of wages growth suggested that the balance of risks had shifted to the upside. The monthly Consumer Price Index (CPI) indicator for October showed that inflation had remained high and broadly based, although the annual rate of inflation had declined a little. The various indicators of activity suggested the economy had grown solidly in the September quarter, supported by household consumption, and demand appeared to have held up into the December quarter.

Members noted that average monthly employment growth over the three months to October had been half that in the first half of the year. With vacancies still very high, some of this slowing was likely to reflect the limited amount of spare capacity remaining in the labour market. Full-time employment had continued to outpace part-time employment, and average hours worked had risen strongly. The unemployment rate had edged back down to 3.4 per cent in October – the equal lowest rate since September 1974. Broader measures of spare capacity had also declined slightly over October, to remain around multi-decade lows, and the rate of participation in the labour force was close to its recent record high. Firms in the Bank’s liaison program continued to report that labour availability remained a key challenge, although there were tentative signs this had started to ease a little.

Tight labour market conditions and high inflation were leading to a further pick-up in wages growth. The Wage Price Index had increased by 1 per cent in the September quarter, to be 3.1 per cent higher over the year, slightly above the Bank’s forecast in November. Members observed that the pick-up in wages growth had been driven by the private sector, while wages growth in the public sector had remained relatively subdued. The weighted-average increase for those private sector jobs that had received a pay rise in the September quarter was 4.2 per cent; the flow-through of the Fair Work Commission’s Annual Wage Review decision to minimum and most award rates of pay had contributed to this strong outcome. A range of more timely measures – such as recently lodged enterprise agreements and information from the Bank’s liaison – indicated that wages growth had continued to pick up in the December quarter. Around 35 per cent of firms in liaison had reported wage increases of greater than 5 per cent in October and November.

The monthly CPI indicator for October confirmed that inflation had remained high into the December quarter but, at 6.9 per cent over the year, the outcome was a little below market expectations. Members acknowledged that the monthly series was still new and needed to be interpreted with caution. Some of the strength in services inflation expected in the December quarter – including in electricity prices, which are measured only once per quarter – would be picked up in the monthly series only in the final month of the quarter, which is released at the same time as the quarterly series. Fruit and vegetables prices had declined in October for the second successive month as production had recovered from the effects of the earlier floods; however, these prices were likely to increase again in the months ahead, following the most recent flooding in south-eastern Australia. Petrol prices had increased by 7 per cent, reflecting the unwinding of the temporary reduction in fuel excise. Rent inflation continued to rise sharply, but the pace of increase in home-building costs had slowed.

Some signs were emerging of easing supply-chain pressures flowing through into reduced actual and expected retail price inflation. In liaison, firms reported that some retailers had become less willing to accept price increase requests from suppliers and were not passing through cost increases in full, given concerns about remaining competitive. More generally, most measures of medium- and long-term inflation expectations remained consistent with the inflation target.

Members noted that, while household consumption had been supported by the strong labour market conditions, growth in consumption appeared to be easing. Retail sales had declined in October, but some other components of household consumption appeared to have held up. In liaison, retailers had reported mixed results for ‘Black Friday’ sales in November. More broadly, there was some evidence of shoppers trading down to less expensive stores and brands. Some retailers had expressed concern about the outlook for 2023, reflecting the effect of rising interest rates and cost-of-living pressures, together with weak consumer sentiment and the wealth effect of declining housing prices. These factors were also weighing on demand for new housing.

Housing prices had fallen further across most capital cities in November, to around 6 per cent below their recent peak, although they were still above pre-pandemic levels. Members noted that rental markets remained very tight and that this was flowing through to growth in CPI rents. A number of demand- and supply-side factors were contributing to the current tightness in the domestic rental market, with further large increases in rents expected over coming years as population growth picks up.

The National Accounts for the September quarter were scheduled to be released the day after the meeting. GDP was expected to have grown solidly in the quarter, with growth in domestic demand led by household consumption. Strong demand for overseas travel by Australians and the filling of order backlogs was expected to have resulted in strong growth in imports.

The outlook for business investment had softened a little but remained positive. The September quarter ABS Capital Expenditure Survey, conducted in October and November, indicated that non-mining firms were expected to increase investment in the 2022/23 financial year, driven by investment in both machinery and equipment and non-residential construction. Capacity utilisation remained very high across most industries. Members noted that business confidence had declined slightly in October, though reported business conditions remained above average.

International financial markets

Members observed that central banks had continued to raise policy rates and signal that further increases are likely to be needed to return inflation to target. However, some central banks, including the US Federal Reserve, were signalling reductions in the size of future increases, noting early signs of a moderation in economic activity and inflation; some had also cited the risk of over-tightening given lags in the transmission of monetary policy.

Market participants’ expectations were still for policy rates to peak in mid-2023 and then gradually decline. Expectations for peaks were generally little changed over the prior month, but policy rates were expected to decline more quickly from the peak in response to lower-than-expected inflation in some economies, most notably the United States. Members observed that market expectations for peak policy rates were highest for countries where wages pressures had been strongest – including Canada, New Zealand, the United Kingdom and the United States. The Reserve Bank of New Zealand had communicated that a significant reduction in demand would be necessary to return inflation to target over the forecast period.

Members noted that the speed and strength of the various channels of the transmission of monetary policy differed across advanced economies. A key variation was the speed of pass-through of policy rates to the interest rates paid by households on their mortgages. In particular, average outstanding mortgage interest rates had increased at a faster rate, and by more, in Australia than in comparable countries, owing to the much higher share of variable-rate mortgages in Australia.

Longer term government bond yields had declined in most economies over the prior month, driven by the decline in longer term policy rate expectations amid signs that inflation may have peaked and the weakening economic outlook. Market-based measures of longer term inflation expectations were little changed at between 2 to 3 per cent in most advanced economies, including Australia. Bond yields had remained volatile, although less so than during the prior month.

Private sector financial conditions had also eased a little. Equity prices in most advanced economies had been rising since mid-October. In China, equity prices had risen with the announcement of further support for the property sector and signs of an easing of COVID-19 restrictions supporting sentiment.

Members noted that the US dollar had depreciated over the preceding month or so, most notably following lower-than-expected inflation in the United States. The Australian dollar had appreciated on a trade-weighted basis since mid-October alongside the lower US dollar, higher commodity prices and some improvement in risk sentiment, to be little changed since the start of 2022.

Domestic financial markets

Members noted that financial market pricing implied around a 75 per cent likelihood of a 25 basis point increase in the cash rate at the December meeting. The market-implied path for the cash rate was slightly lower over 2023 than it had been at the previous meeting. This decline had mostly occurred alongside movements in expectations for tightening by other central banks. Market pricing implied that the cash rate in Australia was expected to peak just above 3½ per cent in the second half of 2023. Market economists expected a similar peak in the cash rate, but that it would be reached by March next year.

Households with mortgages had continued to add to their offset and redraw accounts. Members were informed that these excess payments were accumulating at a slower rate than in the preceding two years when consumption opportunities had been constrained. In aggregate, between April and September 2022, households in all income quintiles had been adding to their excess payment buffers.

Taking into account the increase in mortgage rates implied by financial market pricing for the cash rate and the roll off of fixed-rate loans, required mortgage payments relative to income were expected to increase in 2023 to be equal to their previous peak in 2008. As a share of income, expected required payments in 2023 would also be close to the average level of actual mortgage payments – both required and excess mortgage payments – in 2022.

Equity prices had increased from early October. The total return on Australian equities had been positive since the start of 2022, in contrast to many other countries. In part, this reflected the larger share of resource companies and a smaller technology sector in the Australian equity market. Financial market inflation expectations in Australia were still high in the near term, but remained consistent with the inflation target in the medium and longer term.

Considerations for monetary policy

In considering the policy decision, members began by noting that inflation in Australia remained too high. That was largely attributable to global factors, but strong domestic demand relative to the ability of the economy to meet that demand was also playing a role. While the easing in the monthly pace of inflation had been welcome, the monthly indicator was still new and needed to be interpreted with caution, and some further strengthening in inflation was expected in coming months. However, a sustained decline in inflation was expected in 2023, as global supply-side issues continue to be resolved, the recent declines in commodity prices work their way through to consumer prices and growth in demand slows. Medium-term inflation expectations remained well anchored, both in Australia and abroad, reflecting expectations that central banks would do what was needed to reduce inflation. Members noted that it was important that this remained the case.

The Australian economy was continuing to grow solidly. Economic growth was, however, expected to moderate over the following year as the global economy slowed, the bounce-back in spending on services ran its course and growth in household consumption slowed in response to tighter financial conditions.

Members observed that the labour market remained very tight. The unemployment rate remained at its lowest level in nearly 50 years, and job vacancies and ads remained high. Wages growth had continued to pick up from the low rates of recent years and information from the Bank’s liaison indicated that it was expected to pick up further. Members discussed the upside risk to wages growth, which stemmed largely from the tight labour market and high inflation.

The Board considered several options for the cash rate decision at the December meeting: a 50 basis point increase; a 25 basis point increase; or no change in the cash rate.

The arguments for a 50 basis point increase stemmed from the fact that inflation remained too high and the economy continued to operate with excess demand. Some other economies had earlier been in a similar situation to Australia and had subsequently seen wages growth pick up strongly, which risked high inflation becoming entrenched. In these cases, returning inflation to target was likely to involve a period of very weak demand, and possibly a recession. Australia was not yet in such a situation, but the inflation mindset was shifting, with firms more willing to put up prices than a year earlier and upside risks to wages growth potentially building. Moreover, the cash rate was not yet at a high level historically and, if the Board ultimately needed to move to a more restrictive policy stance, it would take some time for this to dampen demand. These factors supported an argument for taking more pre-emptive action.

The arguments for a 25 basis point increase also recognised the need to bring demand and supply in the economy more into balance, but acknowledged that there had already been a significant cumulative increase in interest rates and that the full effects of this adjustment would take time to occur. Moreover, it was possible that the policy changes might be transmitted to the economy more slowly than usual, given the higher share of mortgages taken out with fixed interest rates, households’ large savings buffers and a summer holiday season without social restrictions for the first time in several years. Nevertheless, the policy changes would begin to have more of an effect through the course of 2023.

In addition, members noted that the share of household income being spent on required mortgage payments would reach around its previous highest level in late 2023, based on the market path for the cash rate and the effect of existing fixed-rate mortgages rolling off onto higher rates over the course of the following year. Furthermore, real incomes had been declining and housing prices and sales volumes had also fallen. Together, these factors were expected to weigh on consumption in the year ahead, while global demand was also likely to weaken. An easing of demand pressures in the economy and the ongoing resolution of supply-side problems could be expected to alleviate the risks of a price-wage spiral, particularly given that medium-term inflation expectations remained well anchored.

Finally, the arguments for no change in the cash rate placed further emphasis on the lagged effects of the large policy adjustment to date, and the value in proceeding cautiously in an uncertain environment. However, members noted that the Bank’s most recent forecasts had indicated that, even with further increases in the cash rate as incorporated into the November forecasts, inflation was expected to take several years to return to the target range. Incoming information had not warranted a reassessment of that broad outlook. Moreover, members noted that no other central bank had yet paused.

Members acknowledged that there were arguments in favour of each of these courses of action. They concluded that the case to increase the cash rate by 25 basis points at the present meeting was the strongest one. A further increase in the cash rate was likely to be necessary to achieve a more sustainable balance of demand and supply, but there had already been a material increase in the cash rate in a short period of time and there were lags in the operation of policy. Members also noted the importance of acting consistently, and that shifting to either larger increases or pausing at this point with no clear impetus from the incoming data would create uncertainty about the Board’s reaction function.

The Board expects to increase interest rates further over the period ahead, but it is not on a pre-set path. Members noted that the size and timing of future interest rate increases would continue to be determined by the incoming data and the Board’s assessment of the outlook for inflation and the labour market.

Members noted that there was considerable uncertainty about the outlook. While household spending was expected to slow over the period ahead, the timing and extent of this slowdown was uncertain. Another source of uncertainty was the outlook for the global economy, which had deteriorated. The Board would also continue to play close attention to the price-setting behaviour of firms and the evolution of labour costs, given the importance of avoiding a price-wage spiral. The Board is seeking to keep the economy on an even keel as it returns inflation to target, but these uncertainties mean that there are a range of potential scenarios. Members agreed that the path to achieving the needed decline in inflation and achieving a soft landing for the economy remained a narrow one.

Recognising this uncertainty, members noted that a range of options for the cash rate could be considered again at upcoming meetings in 2023. The Board did not rule out returning to larger increases if the situation warranted. Conversely, the Board is prepared to keep the cash rate unchanged for a period while it assesses the state of the economy and the inflation outlook.

Members emphasised that the Board’s priority is to re-establish low inflation and return inflation to the 2 to 3 per cent target range over time. High inflation damages the economy and makes life more difficult for people. The substantial cumulative increase in interest rates since May has been necessary to ensure that the current period of high inflation is only temporary. The Board remains resolute in its determination to return inflation to target and will do what is necessary to achieve that outcome.

The decision

The Board decided to increase the cash rate target by 25 basis points to 3.1 per cent. It also increased the interest rate on Exchange Settlement balances by 25 basis points to 3 per cent.